Is Canadian economy paying the price for Carney's hands-off policy on the loonie?

OTTAWA - High-profile central banker Mark Carney is taking it on the chin these days with blows landing from both sides of the Atlantic.

The former Bank of Canada governor, who made international news last year by jumping ship to head the storied Bank of England, has been undergoing a serious grilling in London over the bank's tame response to manipulation of foreign exchange rates.

And in Canada, CIBC (TSX:CM) chief economist Avery Shenfeld has written a note suggesting Carney may have left his successor, Stephen Poloz, with an economy more damaged than it needed to be.

In Shenfeld's view, Poloz's puzzle about why Canadian exporters have not been able to take advantage of the expanding U.S. economy can be traced to decisions Carney made in 2009 and 2010 when Canada was coming out of recession.

To boost growth, the Bank of Canada slashed interest rates that stimulated consumer spending and housing, and it worked. Canada's economy came out of the slump quicker and stronger than any other country in the G7.

But Shenfeld said Carney failed to check the appreciation of the Canadian dollar as foreign central banks dumped the U.S. currency and bought up loonies, at that time regarded as a safe haven.

The loonie's ascent to above parity with the greenback — a gross overvaluation that was not based on fundamentals — came at a critical time in the business cycle when firms were making investment and location decisions about where to place production capacity. For many, the decision was — not in Canada.

"In effect, monetary and exchange rate policy traded off more condos for fewer factories," Shenfeld says, "and we see the signposts of that in recent trends."

The Bank of Canada, even under Poloz, has made it a stated policy not to intervene in currency markets, but Shenfeld says the current governor's "dovish talk" has, in effected, succeeded in sinking the loonie to more appropriate levels, at around 90 cents US.

Shenfeld said in an interview he is not being a Monday-morning quarterback in his criticism.

"In 2009, I said the Bank of Canada should intervene. My argument was that other central banks were intervening in our foreign exchange rate by selling U.S. dollars and buying Canadian dollars, so we should have moved to neutralize that with an offsetting transaction," he explained.

"The Bank of Canada took a hands-off attitude, unlike the Swiss, (and) let the exchange rate move with those capital inflows and it came at a critical time when businesses were making location decisions."

In recent public statements, Poloz and other bank officials have speculated that part of Canada's difficulties returning to pre-recession levels in exports is there are about 9,000 fewer Canadian exporting companies in existence than was the case in 2008, and others have ramped down production capacity.

The impact of such an exodus is that even if foreign demand for Canadian products increases, there simply aren't enough companies around to fill it.

Shenfeld says the currency issue is not the only explanation, but having the dollar appreciate in value at a time the economy was still on its knees and commodity prices were relatively low did exact a price.

"That was a period in which, left with excess capacity after the recession, manufacturers were making long-term decisions on where to retain plants, and where to shutter them for good," he says.

"That wasn't only in the auto sector, but in the likes of food procession, locomotives and steel making."

Now that the dollar is at a more appropriate level and commodity prices are improving, the trade balance should start improving, Shenfeld adds.

"But given how infrequently production location decisions come up, the legacy of earlier plant closures will be with us for years to come."

As such, the CIBC has lowered its forecast for growth in 2014 to 2.1 per cent — almost half a point lower than the central bank's expectation — on the assumption the rising economic tide in the U.S. won't lift the Canadian boat nearly as high as it would have in previous eras.